Chapter 1 What Is Insurance?

• Library: The Commercial Property Insurance Policy Deskbook (ABA) (2018 Ed.)

CHAPTER 1 What Is Insurance?

Insurance is a contract that requires an offer to provide insurance to a person or entity, acceptance of the offer, and payment of consideration called a premium. Insurance is defined by California Insurance Code as "a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event."¹

As such it is a special type of contract because it is limited to provide protection only from a contingent or unknown event. Any loss to be covered must be fortuitous, accidental, contingent or unknown. An intentional act should never be the subject of insurance.

Insurance, otherwise, is just like any other contract.

What Is a Contract?

A contract is a legally binding, valid agreement between two parties. The law considers a contract to be valid if the agreement contains all of the following elements:

• offer and acceptance;
• an intention between the parties to create binding relations;
• consideration to be paid for the promise made;
• legal capacity of the parties to act;
• genuine consent of the parties; and
• legality of the agreement.

An agreement that lacks one or more of these elements is not a valid contract.

Insurable Interest Must Exist to Acquire Insurance

The applicant must have an insurable interest in the property whose risk of loss is sought to be insured.

An insurable interest is any interest in property where the insured might be damaged if the property is lost. For example, the owner of a warehouse has an insurable interest in the structure because his ownership interest would be damaged or destroyed if the structure is lost. On the other hand, the owner's mother-in-law has no interest in the property and could not acquire insurance in her name.

Consider the situation where Mrs. Jones is allowed to live rent free in a home owned by her children. Mrs. Jones purchases, in her name alone, a policy of homeowners insurance, insuring her against the risks of loss to the structure and its contents. If a fire destroys the house, Mrs. Jones can recover because her interest in the house is an "insurable interest." This means she has an interest in the property sufficient that she will suffer a loss if the property is damaged or destroyed. Mrs. Jones's children, the owners of the home, also have an insurable interest in the home, but are not insured under Mrs. Jones's policy and may not recover any proceeds from the policy.

In California, as in most states, in common parlance, we speak of a house as being insured, but, strictly speaking, it is not the house but the interest of the owner therein that is insured. Whether that interest is founded upon a legal title, an equitable title, a lien, or such other lawful interest as will produce a direct and certain pecuniary loss to the insured by its destruction, the person insured has an insurable interest in the property.

Only a person who is both an insured and who has an insurable interest may obtain indemnity from a policy of first party property insurance. In Russell v. Williams, the California Supreme Court stated the rule:

It is a principle of long standing that a policy of fire insurance does not insure the property covered thereby, but is a personal contract indemnifying the insured against loss resulting from the destruction of or damage to his interest in that property.²

The property is not insured against destruction. The insured is guaranteed against loss, to the extent of his insurable interest, not exceeding the amount stipulated in the insurance contract. As the betterments and improvements installed in the building passed to the owner at the expiration of the lease, in part consideration for the rent, the tenant could not sell them, or remove them, or recover their value. It had no other insurable interest than the right to use them until the expiration of the lease. The use interest is insurable but is not the same as an ownership interest.³

In Hulme v. Springfield Life Insurance Co.,⁴ the plaintiff was the beneficiary of a life insurance policy of his business associate. The court held that the plaintiff had an insurable interest in his business associate's life because of the close business (economic) association between the two men, which involved extensive sharing of business assets. Since both parties substantially depended on each other, an insurable interest existed.

To establish the existence of an insurable interest, the interest must be real and supported by evidence, or the right to recover will fail.

Property owners hold real estate in trust in order to avoid probate costs, estate taxes, and legal challenges to a will. In Burns v. California Fair Plan,⁵ the Court of Appeal held that multiple insureds cannot recover more than the value of the property destroyed on a fire insurance claim resulting from a single occurrence. In reaching that conclusion, the Burns court expanded on key insurance concepts including "insurable interest," the purpose of property insurance and "other insurance."

California Insurance Code defines insurable interest as "[e]very interest in property, or any relation thereto, or liability in respect thereof, of such a nature that a contemplated peril might directly damnify the insured, is an insurable interest."⁶

A policy does not insure property itself but instead insures the policyholder's "pecuniary interest" in preserving the property from destruction. Refusing to allow the double recovery, the Burns court stated:

Our Supreme Court long ago recognized the nature of insurance does not provide for recovery in excess of the value of the property destroyed where there is but one loss.

(i) As a contract of indemnity, not a source of potential profit, a policy's "sole purpose is to guarantee against loss or damage." Burns' "life" interest was limited by her life span, and the trust's remainder interest depended on how long Burns survived. So both could not recover the full value of the loss.⁷

The court rested its decision that the two policies should share in the loss in a pro rata fashion on the "other insurance" clause of the standard California Fire Insurance policy. It found that "other insurance" exists when several insurers issue policies covering interests in the same property. Typically, this arises when policies are purchased separately by seller and buyer, lessor and lessee, mortgagee and mortgagor, joint owners, or, life tenant and remainderman. In such an instance, the specific terms of the policies' respective "other insurance" clauses dictate how the insurers must pay on a loss.

Every first party property policy contains a limitation not specified on the declarations page, for example, that an insured should recover only up to the amount of the insured's insurable interest in the property. To allow any more would cause a profit, turn insurance from indemnity to a wager, which would greatly tend to the destruction of like property under like circumstances, and open the door and tempt men to enter therein for fraudulent purposes.

Permitting a double recovery would encourage some property owners to damage their own properties intentionally and make claims for more than their insurable interest. In order to indemnify and not enrich, a property loss involving several insureds and "other insurance" warrants a total payment no greater than the insureds' combined insurable interests. It cannot support payment of an amount in excess of the loss suffered.

An insurable interest may be entirely disconnected from any title, lien, or possession, and may derive solely from possession, enjoyment, or profits of the property, as well as other certain benefits growing out of or dependent upon it.

Under Florida law, property insurance contracts are enforceable only where the insured has an insurable interest in the covered property at the time of the loss.⁸

An insured does not need to own property to have an insurable interest. Instead, Florida law defines an insurable interest as an "actual, lawful, and substantial economic interest" in keeping the property "free from loss, destruction, or pecuniary damage or impairment."⁹

How Does a Person Obtain an Offer of Insurance?

When a person or a business decides he, she, or it needs to obtain insurance to protect against the risk of loss of real or personal property they must understand what insurance is and how it is obtained.

To obtain an offer of insurance the prospective insured needs to make contact with the insurer.

Contact is made by use of an insurance agent, an insurance broker, or directly to a special kind of insurer known as a direct writer. Each will start the process of obtaining insurance by requiring that the prospective insured submit an application for insurance. The application is designed to provide potential insurers with sufficient information to allow an insurer to understand the risks of loss that are faced by the prospective insured.

The application—whether presented through an insurance agent, insurance broker, or directly to a direct writing insurer—is a request that an insurer make an offer for insurance. It is a means of introducing the prospective insured to insurers from whom it seeks insurance.

Applications vary depending on the type of insurance sought, the insurance agent or broker, the insurer, or the person or entity that is seeking insurance. Most insurers that provide commercial first party property insurance—the subject of this book—use a standard form of application created by the Association for Cooperative Operations Research and Development (ACORD). ACORD is a nonprofit organization that produces for the insurance industry, applications and policy wordings for the use of insurers.

Established in 1970 as a nonprofit organization, ACORD was formed by insurance carriers and agents focused on building efficiencies in the U.S. property casualty insurance market. Originally termed the Agent Company Operations Research and Development Organization, its...